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PRESENTATION AT THE ICRIER SILVER JUBILEE SEMINAR Rajiv B. Lall MD & CEO, IDFC NEW DELHI November 6, 2006 1 GOVERNANCE IS KEY Governance is the fundamental theme that cuts across all aspects and segments of infra development challenge Inter Departmental Issues Centre State Tension Rural Urban Divide Public Private Competition Infra development is especially vulnerable to conflicts and tensions in these four dimensions -- their resolution is all about governance 2 Governance must improve to meet the new challenge… Our ability to implement reforms, and indeed our choice of reform options is constrained by the reality of our political economy and the quality of our governance Theoretical, first best solutions are a useful beacon, but reform initiatives must be designed and sequenced taking due account of the realities of political economy However, it is not possible beyond a point to design measures that skirt around poor governance. The bottom line is that we will not be able to meet the challenge of infrastructure development unless we tackle governance 3 The infrastructure agenda Finance Roads and ports Urban Power Capacity building 4 Infrastructure Financing: Context Infra spend (GFCF): 2005/06 % of GDP USD 2010/11 % of GDP USD Central Govt 0.5% 4b 1.0% 12b Central PSUs 2.1% 17b 3.0% 35b State Govts & their enterprises 1.0% 8b 1.0% 12b Private Sector 0.9% 7b 2.5% 30b Total o/w Financed through: 4.5% 36b 7.5% 90b Govt Bonds 1.7% 14b 2.0% 24b Domestic credit o/w from Banks 1.5% 0.8% 12b 6b 3.0% 1.2% 36b 12b Pvt. domestic equity finance 0.3% 2b 1.0% 12b Internal accruals 1.0% 8b 1.5% 18b USD 350b over 5 yrs Domestic Savings/GDP 30% 34% Financial Savings/GDP 15% 19% Infra spend/Financial Savings 30% 37.5% 39% 5 Infrastructure Finance: Context Domestic savings seem tight although the constraint is not insurmountable Overall savings effort may not be a challenge, but intermediation will be Foreign savings (current account deficit) of about 2% should be enough to sustain a higher investment ratio, provided domestic savings effort improves through demographics and FRBM Priority to foreign equity capital -- will need 0.5 percent of GDP per year In addition targeted access to long term debt finance from overseas would help May not be possible/ desirable for domestic banks to finance growing share of infra financing needs: need for other channels of intermediation In our base case, infrastructure’s share in incremental bank credit would have to more than double from 8% to over 36% => exposure limits? Banks will be equity constrained (especially after Basle II) to fund non recourse loans ALM (duration) mismatches will make banks vulnerable to interest rate risk 6 Infrastructure Finance: Recommendations Encouragement to domestic and foreign financial investors for equity capital Implement recommendations of Patil Committee on debt capital markets especially with respect to development of market for securitized assets Allow insurance companies and PFs to invest in funds and/or SPVs owning infrastructure assets (relax requirement of dividend history for such investments) Allow minimum funds under management as eligibility criterion instead of net worth for financial investors bidding for infra assets Allow insurance companies, PFs and IIFCL to buy investment grade securities of long term infrastructure focused CLOs and CDOs Allow FIIs to buy tranches of long term infrastructure focused CLOs and CDOs Encouragement to infrastructure focused NBFCs Allow these NBFCs automatic access to ECBs at least from multilaterals and reputed regional financial institutions Allow insurance companies, PFs, and IIFCL to invest in long term investment grade bonds issued by these NBFCs 7 Road and Ports Sector: Context First generation initiatives reasonably successful GQL in roads, privatization of berths in major ports, development of private minor ports Next generation of challenges: Central government institutions unprepared for scale of PPP engagement needed in the sector Confusion between role of government as policy maker, regulator and operator State level focus/resource allocation to road/port development very patchy Inter-modal connectivity and competition issues have been neglected with risk of new bottlenecks 124,300 km of State Highways constitute 4% of road network and carry 40% of traffic (similar to NH traffic share) are grossly under funded 8 Road and Ports Sector: Recommendations Focus MoSRTH on policy making framework; allow NHAI and Port Trusts greater autonomy and clear responsibility and accountability for execution Training and infusion of professional expertise in PPP management and project development for NHAI and Port Trusts is critical Strengthen legal provisions with respect to ability of NHAI and Port Trusts to contract independently with private concessionaires – the National Highways Act, NHAI Act, Indian Ports Act, Major Ports Act Create strong and independent dispute resolution capacity Formulate national integrated transport policy framework Create inter-ministerial (roads, ports, rail and airports) forum/group to develop and review inter-modal transport policy blueprint on regular basis 9 Road and Ports Sector: Recommendations Focus on State Highway development Central government can play a more active role in steering state level road development and formulating a common framework Would reduce states’ time and efforts to initiate a medium term investment program. To include models for road development policy, state highway act and road funding. All states to prepare a road data base and master plan for road development and maintenance by all states Create state highway authorities with modern management systems and set up state level dedicated road funds – the Madhya Pradesh model could be replicated more widely across other states 10 Urban Infrastructure: Context Trends in Urbanization Large and medium sized cities growing very fast (although overall pace of urbanization is slower than might be expected) Even faster growth of slum population in these cities Rising income levels in these cities leading to rapid increase in demand for services backed by growing ability and willingness to pay Trends in Decentralization Disconnect between mandate of ULBs and their ability to deliver on this mandate growing in part as a result of the 74th amendment Insufficient decision making autonomy for ULBs in part due to jurisdictional confusion and in part due to very weak institutional capacity No financial autonomy due to very weak fiscal base and low credit worthiness Overdependence on state governments 11 Urban Infrastructure: Recommendations Introduce a Local Benefit Tax (LBT) 1% of sales turnover at the final stage (i.e. when registered dealer sells to unregistered persons) Applicable uniformly across urban and rural areas to avoid perverse locational incentives No new skills, manpower or rules are necessary To be collected by state level Sales Tax Departments (through retail invoice) for a fee to be paid by local bodies Collections to be transferred immediately to ULBs (based on origin) and Zilla Parishads (for rural areas) Increase ULB revenues by 30% and is likely to grow annually by an estimated 1520% and would replace inefficient octroi Ensure that property tax reform efforts are not compromised because of this 12 Urban Infrastructure: Recommendations Ensure that elected and accountable persons are given executive power for Use the JNNURM to nudge ULBs in this direction ULBs Create specialized nodal unit for urban infrastructure in every state Replicate TNUDF (with appropriate learnings) to act as lead agency for JNNURM Repository for scarce project development skills Facilitate financial engineering for pooled financing structures to improve access to capital markets 13 Power Sector: Context Power deficit is growing despite policy framework Financial situation of SEBs has shown marginal improvement Not so much because of reduced T&D losses, but due to growing share of HT consumers Payment security still a major constraint to financial closure of large projects Growing private sector appetite for investment in generating capacity Capacity not keeping pace with industrial demand (shortfalls in public sector targets and insufficient capacity addition by private players) A number of private projects caught in unresolved inter-departmental, inter-state, publicprivate conflicts Little progress on open access Based on premise that if you can produce at cost lower than median for SEBs, then worth taking merchant risk in a market where demand far outstrips supply Two immediate priorities: Accelerating the pace of capacity addition especially from private sector Improving the efficiency of distribution 14 Power Sector: Suggestions Clear framework for privatization of coal mines for use in power generation Speedy resolution of issues pertaining to gas pricing Explore incentives for states to allow open access APDRP scheme should be overhauled such that GoI assistance for SEBs is tied to the latter meeting time bound targets for open access to HT consumers in their respective states GoI should insist that the private promoters under the proposed Ultra Mega Power Projects be allowed to sell a portion of the capacity on an unrestricted merchant basis 15 Power Sector: Suggestions Move towards separation of urban from rural distribution load stations Characteristics of urban and rural electricity distribution are very different reflecting different client needs, abilities to pay, and delivery challenges Segregation would make distribution subsidies more transparent and better targeted. It would also help reduce theft (which is more concentrated in urban areas and is partly camouflaged in mixed zones through over reporting of non-metered subsidized agricultural consumption) Implementation would have to be state-specific and could take different forms (creation of separate companies or SBUs or ring-fencing arrangements within same company) Financial incentives may be needed upfront to facilitate segregation, followed by milestone based incentives linked to outcomes Intense strategic communication would be required to convince that segregation does NOT entail a pro-urban bias 16 Capacity Building for PPPs: Context A PPP program must be a partnership of equals complemented with strong regulatory oversight, and effective dispute resolution mechanisms Shortage of skills needed to design/develop/manage projects suitable for long term contractual partnerships with private players, compounded by frequent staff rotation -- not all skills can be outsourced to consultant No institutional mechanism to share lessons and reluctance to spend for project preparation Regulatory capacity and dispute resolution is weak Danger of government abdicating its responsibilities or of inappropriate allocation of risks/responsibilities 17 Capacity Building for PPPs: Recommendations Training and sensitization Create state level PPP units to provide hand-holding to various departments Specialized programs in training institutions (IIMs, IEG, NIPFP) In house training Given the sheer scale of PPP requirements, might be worthwhile setting up a dedicated institute for the express purpose of training a PPP management and regulatory corps Assist in inter-departmental coordination Act as repository of project development and transaction skills Disseminate lessons across sectors Create a fund that states and central departments can access to finance project preparation costs 18 Conclusions Resource constraints are not insurmountable. Immediate challenge is to encourage diversified and more effective intermediation of savings such that it meets the needs of infra development – simple measures to facilitate the participation of financial investors for equity capital, kick-start domestic debt capital markets, and improve access to long term foreign debt financing would go a long way Considerable progress could be made through better prioritization of reform initiatives (e.g. state highways, inter-modal connectivity); and through creative, yet practical, design (e.g. the LBT, separation of urban from rural electricity distribution). The harder problems pertain to pervasive institutional deficiencies and the full range of governance issues – eliminating the infrastructure deficit will require us deal with these problems head on 19